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When the commercial paper market contracted and interest rates ballooned in the wake of the Lehman Brothers bankruptcy, Sears Holdings, like most corporate issuers, dialed down its use of such financing. Historically, the firm had regularly tapped CP. Like most companies, Sears found the unsecured, short-term debt instruments — which mature in 1 day to 270 days — handy for financing accounts receivable, inventories, and short-term liabilities. But as of January 31, 2009, Sears had only $7 million of unsecured CP outstanding on its balance sheet.

Sixteen months later, however, the retail giant is back in: as of May 1, its CP outstanding has risen to $498 million. In the interim, the company renegotiated its revolving line of credit agreement. With a 575 basis-point rate on the renewed revolver, and Sears paying CP rates of 190 basis points annualized, the cost-of-funds benefit from issuing CP was too good to pass up.

Indeed, for nonfinancial companies generally, short-term borrowing of the CP variety is back. After the dislocations of the market 20 months ago, and despite the overall market having shrunk by $1 trillion since April 2007, there is strong demand for nonfinancial CP issuance of every credit quality.

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“Clearly, the segment of the market that is the best functioning [now] is the nonfinancial market,” says Rob Little, managing director of global fixed income origination at Bank of America Merrill Lynch. “It’s always been considered the bread and butter.”

The total U.S. market for CP expanded for two weeks in a row in late June, hitting $1.099 trillion the week of June 23, a rise of $15.4 billion. Financial institutions issue the bulk of CP debt, but the attractiveness of that paper is now highly contingent on the sentiment surrounding banks’ health and overall macroeconomic trends.

“The nonfinancials have very good liquidity out to three months, and select issuers can go out four to six months,” says Little. “The vast majority of financials are shorter duration.” In addition, CP is cost-effective. Rates on one-month paper issued by AA-rated nonfinancial companies were at 19 basis points recently, after rising above 200 basis points in September 2008.

Little says more nonfinancial companies are starting to rebalance their portfolios to include larger components of short-term, floating-rate borrowing. Indeed, Sears Holdings is in a select group. Of all U.S. nonfinancial companies in 2009, it was in the top 10 of companies that increased their CP borrowings the most (measured as a percentage of total debt). The other 9 were Harris Corp., Equifax, Public Service Enterprise Group, Franklin Resources, XTO Energy, South Carolina Electric & Gas, FMC Technologies, Moody’s Corp., and Ryder System. (The list is based on a CFO analysis of data provided by Capital IQ.)

At the end of March, FMC Technologies, which manufactures subsea production and processing systems for the oil and gas industry, had $350 million in CP outstanding on its books, compared with just $52 million at the end of 2008. “We’re kind of agnostic on which lending source we use,” says Bill Schumann, FMC’s finance chief. “Historically, commercial paper has always been cheaper.” At the end of 2008, when financial markets were still roiling, FMC, an A2/P2 issuer, was paying 106 basis points over LIBOR and “availability wasn’t very good,” he says. But now FMC pays between 10 and 20 basis points over LIBOR in the CP market. That compares favorably with a rate of 45 points over LIBOR for FMC’s revolving line of credit. “If we had to redo the revolver, the rate would be closer to 225 or 250 [basis points],” adds Schumann.

Despite the bargains, overall dollar issuance of CP among nonfinancials is still down. According to the analysis of Capital IQ data, nonfinancial U.S. companies (those not strictly categorized as financial-services firms) had only $128 billion in CP borrowings outstanding at the end of last year, the lowest total in almost a decade. That compares with $232 billion in 2008 and $278 billion the year before.

So why aren’t more companies jumping in? It will take a while for the market to recover fully, says Little, because many companies hit the bond markets so hard in 2009 that they have excess cash positions. In addition, economic activity is low. “You don’t see as many inventories and receivables being created,” he says. The lack of a robust merger-and-acquisition environment is another contributing factor, as CP serves as an interim source of M&A financing.

But a second boom of the CP market may not be far off. With banks reducing many companies’ lines of credit and term debt, and forcing them to pay higher rates when they renegotiate lines, CP is now priced better than many bank facilities. In addition, if the timing of cash flows remains very uncertain for companies, more CFOs may turn to CP for its flexibility. At the same time, though, CP does harbor liquidity risk, and it runs counter to companies’ desires to extend debt maturities and lock in low-cost funding.